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Everything we see indicates that the hospital industry is really feeling the financial squeeze these days. Large health insurance networks are forcing significant reductions in prices, there is a shortage of skilled health care labor resulting in increases in labor costs, and the cost of compliance with various government regulations continues to rise. In an environment like that, the last thing that a hospital should want to do is to needlessly send money to the government in order to maintain its legacy pension plans.
October Three studies show, however, that a greater percentage of hospitals sponsor defined benefit pension plans than almost any other industry. And, strikingly, those same hospitals appear to be paying more in unnecessary premiums to the Pension Benefit Guaranty Corporation (PBGC) than we see in any other industry. [1]
Why is this happening? Do those unnecessary payments provide any benefit to the hospital or to plan participants? Is there something they can do to stop paying more than is necessary? What does all this mean in non-pension terms?
In what follows, we’ll answer all of these questions, beginning with some general principles and ending with the bottom line.
Generally, all sponsors of qualified defined benefit plans pay annual premiums to the PBGC. In return for those premiums, PBGC insures benefits of plan participants in the event that the plan is not able to pay those benefits, and the sponsor is no longer able to fund the plan. Those premiums fall into two categories – a flat-rate premium of $80 for each plan participant (including active and terminated employees), and a variable-rate of as much as $541 for each of those same participants where the precise amount depends upon how well or how poorly funded the plan is. Fully funded plans pay no variable-rate premiums; particularly poorly funded plans pay the full $541 per participant in variable-rate premiums; plans funded somewhere in the middle tier pay amounts between $0 and $541 per participant.
These premiums function as something like a tax. The benefit the sponsor gets – benefit insurance – doesn’t change if the sponsor pays more premiums (more “tax”). So overpaid premiums are, in effect, “lost money.”
An October Three study, based on publicly available information, analyzing PBGC variable-rate premiums of every defined benefit plan with 200 or more participants, found that more than in any other industry, hospitals were failing to apply techniques that might reduce those premiums.
If you’re one of those hospitals, it’s likely not your fault. You don’t have a PBGC premium specialist on your staff. More than likely, the plan’s actuary tells you how large a check you need to write and you do it. If you do write a check for more than you truly need to, be assured that (as we said) the excess amount provides neither you nor your employees, present or past, with any benefit at all. None.
The ways to avoid these excess payments are really quite simple. One is as easy as making sure that your plan’s actuary records your contributions to the plan for as early a plan year as possible. Doing this effectively reduces your underfunding and thus reduces your variable-rate premiums. In our experience, many actuaries who are not focused on reducing premiums miss this issue.
The second technique, while still simple, does take a bit more thought. In a nutshell, what we would like you to consider is making contributions to your plan just a little bit earlier than you have to. Suppose, for example, that we told you that by contributing $1 million 30 days earlier than you are required to would save you $43,000. That’s a 4.3% return for tying up your money for one month. Surely, your cost of capital for one month is not 4.3%. If you like that strategy, then you may be able to extend it by making additional contributions early. In simple terms, you are going to get a return on your investment (reduction in costs) that far exceeds your hurdle rate.
To illustrate the magnitude of this problem, October Three looked at real information for five hospitals.
For the 2016 premium payment year (generally, the calendar year), total lost savings opportunities were nearly $3.4 million. And, for the 7-year period ending with the 2016 premium payment year, the same missed savings opportunities exceeded $7.5 million. Those are significant numbers in an industry where margins are particularly tight, especially since passage of the Affordable Care Act in 2010.
Drilling down a bit deeper into the financials of one of these five hospitals, we found an even more glaring issue. For 2016 alone, we found that one hospital, had it chosen to take the savings opportunities that we’ve identified here, would have increased its profits by 5.75%. A hospital whose profit per bed was about $32,000 per bed missed savings opportunities of nearly $1,900 per bed.
Why are we finding this problem in such large numbers with hospitals? We can’t be certain, but we do have some thoughts. Of the hospitals that have pension plans, many are mature organizations. They have significant legacy liabilities that are related to former employees who have not worked at those hospitals for many years. Perhaps there is the mindset that once they are gone, there is little, if anything that can be done to fix what is perceived as a problem from a generation past.
When pension costs are viewed as due to former employees, they may be considered uncontrollable; that is, they are a labor cost that the hospital is just stuck with. However, as the data above show, that is not the case.
Frankly, the hospitals that are missing opportunities should not view this as management failure. Determination of PBGC premiums is a fairly technical calculation not likely to be fully understood by anyone in-house. The hospital’s actuary gives the hospital a number – the amount that they need to pay to the PBGC – and they pay that amount, generally without questioning it. While the hospital has departments focused on cutting the costs of supplies and utilities, for example, none has a PBGC premium-reduction department.
If you are in management of a hospital and have a pension plan whether it’s ongoing or frozen, October Three can tell you if you are missing savings opportunities. If you are, we can help you to fix them. And, in addition to those basic opportunities, there may be others that we can identify to stop PBGC premiums from eating into those revenues and making each of your beds as profitable as it should be.
[1] Based on October Three data gathered from publicly available information.